A cut in planned government spending could help tame rampant inflation and reduce pressure on the Bank of Canada to hike interest rates, according to a report from Scotiabank.
The report from the bank’s chief economist Jean-Francois Perrault and modeling director René Lalonde claims that Canadian fiscal policymakers are “doing nothing of any significance to slow inflation at the moment.”
The authors argue that cutting government spending will take some of the burden to cool inflation off of the Bank of Canada and the private sector.
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Scotiabank’s analysis came as Canada’s Deputy Prime Minister and Minister of Finance Chrystia Freeland is met with the head of the US Treasury Janet Yellen in Toronto on Monday to discuss cooperation between the nations and the global inflation concerns.
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The report cites the Bank of Canada’s renewed mandate from December of last year, which said tackling inflation is a “joint responsibility” between the feds and the central bank.
While the war in Ukraine and ongoing supply chain pains tied to the COVID-19 recovery have been cited as major causes of higher-than-expected inflation so far in 2022, Perrault told Global News in an interview Monday that prices were on the rise before Russia’s invasion.
That was tied to stimulating fiscal policies from governments around the world, which sought to protect households from the pandemic’s downturns, he said.
Though he said efforts to trim the government’s deficit in the spring’s federal budget were “going in the right direction,” Perrault said the latest Liberal spending plan is still contributing to the economy and fueling demand.
“In normal circumstances, that’s fine. The challenge in the current circumstance is we have inflation that is a huge issue from the perspective of Canadians. It’s well outside what the Bank of Canada wants. It’s exceptional, there’s no question about it,” he said.
In this context, he said he believes the Bank of Canada “could benefit from a little help” in the form of cooling government spending.
Scotiabank projects that if the feds plan to increase their spending 2.5 per cent by the end of 2024, instead of today’s planned 4.8 per cent increase, the Bank of Canada could top out its interest rate hike cycle at 2.25 per cent, 75 basis points lower than where Scotiabank forecasts rates will hit by the end of this year.
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But Freeland, speaking alongside Yellen on Monday afternoon, said she felt the feds’ latest budget does go far enough to limit government spending.
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She said the rate of fiscal consolidation — the rate at which Canada is paying down its debts — is tied for the fastest in the G7, on par with the United States.
While Freeland reiterated that tamping down inflation is “chiefly the job” of the Bank of Canada, she said her 2022 spending plan was already a “very fiscally responsible budget.”
She said that was why she stuck with the budget items announced in April rather than announcing new spending last week in her economic update.
“We understand that fiscal policy has a role to play. That’s why we took this decision in April to pursue a path of … fiscal tightening,” she said.
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Statistics Canada is set to announce May inflation figures on Wednesday, with at least two major banks expecting a reading of 7.4 per cent, which would be higher than the 6.8 per cent reading for April.
Scotiabank is among a growing chorus of economic forecasters projecting a 75-basis-point interest rate hike in the Bank of Canada’s next announcement July 13, following the steps of the US Federal Reserve, which took an outsized step last week to try to anchor inflation expectations.
“We think the Bank of Canada will move 75 basis points as well. They don’t really have much of a choice,” Perrault said.
Perrault was the speaker who introduced Freeland at her keynote address to the Empire Club of Canada in Toronto last week when she outlined the feds’ plans to help Canadians tackle inflation.
The finance minister announced no new spending plans in that speech, instead touting $8.9 billion in measures from the government’s previous two budgets that are now coming into effect. Among those plans are boosts to child-care support, old age and worker benefits, as well as $500 in direct support going to low-income renters.
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Perrault said that it’s a “tricky political balance” to directly support Canadians through rampant inflation because fiscal stimulus tends to raise demand for spending in the long run.
“By giving people money, effectively, whether it’s to help adjust inflation or otherwise, you’re continuing to fuel that fire,” he said.
Economist Tu Nguyen of RSM Canada told Global News last week that by targeting inflation support measures to vulnerable Canadians, the feds could thread the needle of mitigating inflation for the hardest hit without fueling too much demand.
“How that plays out in reality remains to be seen,” she said.
Perrault noted that if the central bank can minimize how high interest rates rise in the years to come, it would mitigate a correction in the housing market.
“That would mean lower mortgage rates, it would mean lower cost of financing for Canadians in general,” he said. “It’s certainly less of a financial burden on a part of Canadian households.”
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